Finance 101: What kind of an investment is a home?

When people start thinking about buying their first home, their brains are inundated with all kinds of worthy questions. Some are quality of life questions like, “Where do we want to buy, what kind of house makes sense for us and our lives, and will this make us happier?” Other thoughts inevitably fall into the financial realm. Things like, “What can we afford? Is our credit rating good enough? And is this the best thing for us financially?”

“Buying my house was the best investment I ever made” is a sentiment I have heard expressed by many people when thinking about life and money. You usually hear this from people well after the mortgage has been paid off and their lives have taken on a hue of sentimentality, in their later years. Which is fine, but your home isn’t an investment per se so much as it is a choice about your values and goals.

What is true for many, if not most, people is that their homes are their largest asset. The equity they have built provides them with some resources should they need them. They could tap that equity for some much-needed repairs or that kitchen upgrade. They could downsize their living arrangements to lower costs and the demands for upkeep and then invest their money for the years ahead. And depending on their individual circumstances, they could turn that home equity into a monthly income check via a reverse mortgage. So having that asset is quite helpful in a lot of ways. But how did that asset become so valuable?

Despite what you may have heard about “investing in a home,” the value created isn’t due to “investment returns.” In fact, if you asked the average homeowner, or anyone for that matter, how much homes increase in value over time, you would typically get a range of return expectations. My own personal experience is that most people answer somewhere between 4 percent and 10 percent a year. And they’d be quite wrong. By a lot.

According to a recent posting on Twitter by Charlie Bilello of Pension Partners, an investment firm, the average nominal return on homes was 3.2 percent from 1891 to the end of 2018. So not that bad, huh? Actually, not so great either, because when you adjust that for inflation over those years, you end up with a real return of … 0.3 percent. As in three-tenths of 1 percent. The numbers were derived by using the S&P/Case-Shiller housing index, a closely followed measure used by the U.S. government’s Bureau of Labor statistics. So pretty different than what most people probably think.

And don’t get me wrong. Compounding money above the rate of inflation is a great way to build your wealth. That 0.3 percent real return will compound to close to 10 percent, in real terms, over the life of a 30-year mortgage. Which is better than nothing. But the real heavy lifting is done by your own enforced savings when you pay down the principal of the loan. That’s primarily why you have equity when your mortgage is done.

So why should you care? I would offer two things that are worth your consideration.

First, have a clear understanding of what buying a home actually means. It’s not about a financial investment, although financial issues will always come into play. It’s about starting a new chapter in your life. It’s about stability and predictability and planning for children. It’s really about our hopes and aspirations for a life well lived. As the numbers have shown, it’s really not about money per se. Money concerns will always come into the discussion, but they really are secondary.

The other thought is how miraculous an enforced savings plan really is. With your mortgage, you are forced to pay down the debt, and that is what yields the lion’s share of equity you have built. It’s how you got that money. To take that thought further, what if you forced yourself to save every month? Many people already do this via their 401(k) or other defined-contribution plan, but forcing yourself to save, to blindly put money away regularly, is the real concept. Imagine you have your checking account set up to automatically send $150 per month to your IRA, or to your kid’s college savings account. Do that for long enough, and you’ll be shocked at how much money you actually have squirreled away.

A simple illustration: if you saved $150 per month for 30 years and earned a 5 percent return, you would have over $125,000. Your contributions would have been $54,000. Go another 10, years and you end up with $230,000, having contributed about $72,000. Forcing yourself to save a modest $150 per month goes a very long way.

Like so many things in our lives and personal finances, a new home is less about money and more about what money can do for us, the intangibles which give our lives meaning. And like so many things in personal finance, it’s about doing simple things well enough, like forcing yourself to save, so that you become so used to that process that it basically disappears. But the money grows unnoticed while you enjoy your actual lives. And that is the way it should be.

John Kageleiry is a business writer and financial planner. Have a question for “Finance 101”? Email it to jkageleiry1@gmail.com.

1 COMMENT

Very incomplete article. Appreciation rates vary by area greatly. In ruraL Kentucky there is very little appreciation, and here it is 400% in 20 years. Also, when you own, you don’t pay rent, which is a total waste and not tax deductible. However, I will say this, for investment only, I would choose the next Martha’s Vineyard. I don’t see my more appreciation here for years to come. There are better areas to invest.